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IBF Comments Summary on CEBS' Consultation Paper (CP14) on Large Exposures

Core Content

The Irish Banking Federation (IBF) has provided detailed comments on the CEBS' Consultation Paper (CP14) regarding the first part of its technical advice to the European Commission on Large Exposures. The IBF supports CEBS' consultative approach and the European Commission's ongoing review, but emphasizes the need for a clear agreement on the objectives of a large exposure regime and whether the current framework is still relevant.

Main Views

1. Objectives and Purpose of Large Exposures Regime

• The IBF acknowledges that large exposures are a form of concentration risk, which includes undiversified idiosyncratic risk, sectoral/geographic concentration risk, and unforeseen event risk.
• They agree that the central purpose of the large exposures framework is to limit the risk of traumatic loss that could threaten solvency.
• However, they argue that this objective is now largely addressed under Pillar 2 of the Capital Requirements Directive (CRD), specifically through the ICAAP Principle 8(c) and CEBS' Guidance on Stress Testing.
• They believe that maintaining the Large Exposures Framework alongside Pillar 2 requirements would lead to dual frameworks for managing the same risk, which is inefficient and redundant.

2. Market Failure / Regulatory Failure Analysis

• The IBF disagrees with CEBS' conclusion that there is a material degree of market failure in the context of unforeseen event risk.
• They suggest that such failures may more likely stem from poor management or ineffective internal governance rather than systemic issues.
• They support a 'light touch' approach, where regulatory limits act as a backstop and institutions are expected to manage risk through their own internal systems and practices.

3. Other Jurisdictions

• The IBF agrees that the EU Large Exposures regime is broadly consistent with rules in other jurisdictions.
• However, they point out that significant divergences exist within the EU due to national discretions in the application of the Large Exposures Framework.
• They expect similar discrepancies to exist outside the EU, where rules may be interpreted and applied differently despite similar concepts.

4. Large Exposures Limits

• The IBF agrees in principle that credit quality of the counterparty should not be a factor in determining large exposure limits.
• However, they raise several concerns:
  • Limited scope of collateral recognized in the framework requires a significant review.
  • Double default is not considered, which could reduce the likelihood of loss if both the obligor and the credit protection provider default.
  • Different risk weightings for large exposures and credit risk cause confusion and should be aligned.
  • The 25% limit on single counterparty and connected client exposures is too inflexible, especially when exposures are planned to be removed off-balance sheet.
  • The 800% limit on trading book exposures is seen as unnecessary and restrictive, particularly for Over-the-Counter (OTC) derivatives, where potential future credit exposure (PFCE) methods are not appropriate for large exposures.

5. Calculation of Exposure Values

• The IBF agrees that institutions should be allowed to calculate exposure values in line with their internal risk management practices.
• They suggest that this flexibility should be extended to all institutions, not just those using advanced approaches.

Key Information

• Current Framework: The IBF believes the existing Large Exposures Framework is outdated and no longer aligns with modern risk management capabilities.
• Pillar 2 Alignment: They argue that Pillar 2 already addresses the management of unforeseen event risk through ICAAP and stress testing.
• Light Touch Approach: The IBF supports a regulatory backstop model, where institutions manage risk internally under Pillar 2.
• Collateral and Double Default: These aspects are not adequately addressed in the current framework and should be considered in any new regime.
• Limit Flexibility: The 25% and 800% limits are seen as inflexible and not aligned with real-risk scenarios.
• Exposure Calculation: They advocate for internal calculation methods to be applied universally, not just to advanced institutions.

Conclusion

The IBF concludes that, given the existing Pillar 2 requirements, a one-size-fits-all approach is no longer necessary. They support CEBS' proposal for a 'light touch' regime, which would allow institutions to manage concentration risk through their internal systems while maintaining regulatory oversight as a backstop.